THE EIMCO K.C.P. LTD. MADRASversusCOMMISSIONER OF INCOME TAX,.MADRAS

                  THE EIMCO K.C.P. LTD. MADRAS                                 A
                                     v.
           COMMISSIONER OF INCOME TAX,.MADRAS

                          FEBRUARY 25, 2000

 [D.P. WADHWA AND SYED SHAH MOHAMMED QUADRI, JJ.)                              B

      Income Tax Act, 1961 :

       Sections 35-A and 256( I )-Allowable expenditure-Appellate •Com-
pany, an Indo-American joint venture, allotted equity shares to the Ame1ican   C
Company equivalent to the value of technical know-how supplied-Deduction
of value of technical know-how claimed as revenue expenditure-Income Tax
Officer treated it as capital expenditure and allowed I/14th as allowable
expenditure-While an appeal was pending before the Appellate Assistant
Commissioner-The Commissioner of Income Tax held the expenditure not
allowable-Appellate Assistal!t Commissioner later on dismissed the ap-         D
peal-Income Tax Appellate Tribunal allowed the appeal-High Court on
reference answered in favour of Revenue-On appeal Held, allotment of
equity shares was reimbursement for the technical know-how, which can never
be tenned as expenditure much less revenue expenditure.

     Section 263-Interference with orders of Income Tax Officer-Held, the
                                                                               E
Commissioner of Income Tax could not inter[ere with the order on a point
which was directly in appeal before the Appellate Assistant Commissioner.

      An American and an Indian company collaborated and floated the
appellant company with an authorised capital of Rs. 1,00,00,000 consisting F
of 10,00,000 equity shares of Rs. 10 each. Each of them agreed to subscribe
to Rs. 4,70,000 out of which Rs. 2,80,000 was to be paid as initial contribu-
tion. The American company contributed technical know-how which was
valued at Rs. 2,35,000 and paid the balance in cash. In the assessment year
1969-70, the appellant company claimed deduction of Rs. 2,35,000 as
revenue expenditure for the said technical know-how. The Income Tax G
Officer treated this sum as capital expenditure and allowed only 1/14th of
it under Section 35-A of the Income Act, 1961. The Commissioner of
Income Tax during pendency of the appeal before the Appellate Assistant
Commissioner held that the amount in question could not be treated as
expenditure so granting 1/14th of the said amount as capital expenditure H
                                     1185
    1186                 SUPREME COURT REPORTS                [2000) 1 S.C.R.
A was erroneous. Thereafter, the Appellate Assistant Commissioner dis-
    missed the appeal. The Income Tax Appellate Tribunal allowed the appeal
    of the appellant company holding the said amount to be revenue expendi-
    ture.

         On a reference under Section 256(1) of the Act,        High Court
B   answered in favour of the Revenue. Hence this appeal.

           Dismissing the appeal, this Court

         HELD : 1. On the facts and in the circumstances of the case, the
    Commissioner of Income Tax could not interfere with the orders of the
c   Income Tax Officer on a point which was directly in appeal before the
    Appellate Assistant Commissioner. [1188-D-F]

           Commissioner of Income Tax, Bombay v. Anuitlal Bhogilal & Co., 34
    ITR 30, relied on.
D
          Ram/al Onkannal v. Commissioner of Income Tax, Assam, 44 ITR
    578; Kelpunj E11te1plises v. Commissioner of Income Tax, Kera/a, 108 ITR
    294, approved.

           2. The appellant by allotting equity shares of Rs. 2,80,000 to the
E American Company reimbursed its contribution by way of know-how,
    which can never be treated as expenditure much less an expenditure laid
    out wholly and exclusively for purposes of the business of the appellant.
    This know-how was acquired to produce higher yield and improve the
    quality of the product, which the assessee-company was already manufac-
F   turing. The allotment of equity shares to the American company, in the
    circumstances of the case, cannot be termed as "expenditure much less
    revenue expenditure". [1191-B-F]

         Alembic Chemical Works Co. Ltd. v. Commissioner of Income Tax,
G   Gujarat, (1989) 177 ITR 377, relied on.

          CIVIL APPELLATE JURISDICTION: Civil Appeal Nos. 4058-59
    of 1994.

         From ·the Judgment and Order dated 17.1.83 of the Madras High
H   Court in T.C. Nos. 1224 and 1225 of 1977.
-i        EIMCO K.C.P. LTD. v. C.I.T. [SYED. S. MOHAMMED QUADRI, J.] 1187

          M. Uttam Reddy, A.V. Rangam, B.A. Ranganadhan and G.I.                 A
     Gopalkrishnan for the Appellant.

          B.B. Ahuja, K.N. Shukla, K.C. Kaushik, Ms. Neera Gupta, Ms.
     Sushma Suri, Arvind Kumar Sharma, Mrs. Anil Katiyar, V.K. Verma and
     C. Ramesh for the Respondent.
                                                                                 B
           The Judgment of the Court was delivered by

            SYED SHAH MOHAMMED QUADRI,J. The judgment and order
      passed by the Division Bench of the High Court of Madras in T.C. Nos.
     1224 and 1225of1977 dated January 17, 1983 is subject-matter of challenge
     _in these appeals.                                                          c
             The appellant-assessee is a company registered under the Indian
     Companies Act. It was incorporated in the year 1965. Two companies M/s.
     Eimco Corporation Inc. (for short 'Eimco'), an American company, and
     M/s. K.C.P. Ltd. (for short 'KCP'), an Indian Company, promoted the D
     appellant company. The authorised capital of the appellant was
     Rs.1,00,00,000 consisting of 10,00,000 equity shares of Rs.10 each. Each of
     them agreed to subscribe Rs.4,70,000 out of which each will have to pay
     initially a sum of Rs.2,80,000 towards its contribution. Towards its share
     Eimco contributed technical know-how consisting of right and license to
     manufacture existing Eimco Sedimentation and filtration equipment, along E
     with the supply of and/or the agreement to supply general technical data
     including manufacturing drawings in the form as used and possessed by
     Eimco, relating to the sales, application, selection, material requirements,
     manufacture, installation and operation of such equipment, including but
     not limited to test procedures, instruction manuals, technical manuals, p
     general arrangement and detail drawings, flow charts, research and
     development reports, sales manuals and bulletins, operating reports on
     existing installations and installation and operation manuals. It valued the
     know-how etc. at a sum of Rs.2,35,000 and paid the balance in cash as its
     contribution. The Board of Directors of the appellant allotted equity shares
     of Rs.2,35,000, being of the value of the know-how, to Eimco by resolution G
     passed on April 29, 1968. In the assessment year 1969-70, the appellant
     claimed deduction of Rs.2,35,000 as revenue expenditure paid to Eimco
     towards consideration for supply of technical know-how by it. By order
     dated March 25, 1970, the Income Tax Officer treated that as a capital
     expenditure and allowed 1/14th of the said amount as allowable expendi- H
    1188                 SUPREME COURT REPORTS                   [2000] 1 S.C.R.
A ture under Section 35-A of the Income Tax Act (for short 'the Act'). The
    appellant challenged that order before the Appellate Assistant Commis-
    sioner on the ground that the whole expenditure ought to have been
    allowed as revenue expenditure. While so, the Commissioner of Income
    Tax in exercise of its power under Section 263(1) of the Act revised the
    said order of the Income Tax Officer dated March 25, 1970 holding. that
B   the amount in question could not be treated as expenditure and that
    granting 1/14th of the said amount as capital expenditure under Section
    35-A was erroneous and prejudicial to the interest of the revenue and thus
    set aside the same. Thereafter, the Appellate Assistant Commissioner
    dismissed the appeal and directed that 1/14th amount be added back as
c   income of the assessee. Against both the orders, the appellant filed appeals
    before the Income-tax Appellate Tribunal. The Tribunal, on December 12,
    1975, allowed appeals of the appellant taking the view that the said amount
    was revenue expenditure of the appellant. At the instance of the Revenue,
    the following two questions were referred to the High Court under Section
D   256(1) of the Act :

           "(1)   Whether on the facts and in the circumstances of the case,
                  the Commissioner could interfere, acting under Section 263
                  of the Income-tax Act, 1961 with the order of the Income-tax
                  Officer on a point which was directly in appeal before the
E                 Appellate Assistant Commissioner?

           (2)    Whether on the facts and in the circumstances of the case,
                  the sum of Rs.2,35,000 paid by the assessee company to the
                  foreign collaborator constitute revenue expenditure?"

F         Both the questions were answered in favour of the Revenue and
    against the assessee by the High Court in the impugned order.

          Mr. M. Uttam Reddy, learned counsel appearing for the appellant,
    did not seriously canvass the correctness of the impugned order in regard
    to the first question and in our view rightly. Having regard to Section 263
G   of the Income Tax Act and the decision of this Court in Commissioner of
    Income-tax, Bombay v. Anuitlal Bhogilal & Co., 34 ITR 130 and judgments
    of High Courts of Assam in Ram/al Onkannal v. Commissioner of Income-
    tax, Assam, 44 ITR 578 and of Kerala in Kelpunj Enterprises v. Commis-
    sioner of Income-tax, Kera/a, 108 ITR 294, which we approve, we confirm
H   the answer to the first question recorded by the High Court.
t

        EIMCO K.C.P. LTD. v. C.I.T. [SYED. S. MOHAMMED QUAD RI, J.] 1189

           Regarding the second question Mr. Reddy vehemently contended A
    that the amount of Rs.2,35,000 was paid by the appellant to the foreign
    collaborator to acquire the know-how so it was revenue expenditure and
    ought to have been so held by the High Court. Mr. Shukla argued that
    know-how etc. were contributed by Eimco towards its share of the capital
    and that no amount was paid by the appellant to Eimco; allotment of shares
    to Eimco by the appellant could not be treated as expenditure incurred by
                                                                               B
    it for purchase of know-how.

         To appreciate the contention of Mr. Reddy, it may be necessary to
    quote Section 37(1) of the Intome Tax Act here :

            "37. General. - ( 1). Any expenditure (not being expenditure of the      c
            nature described in Section~ 30 to 36 * * * and not being in the
            nature of capital expenditure or personal expenses of the assessee ),
            laid out or expended wholly and exclusively for the purposes of
            the business or profession shall be allowed in computing the
            income chargeable under the head "Profits and gains of business          D
            or profession".

           A plain reading of the above provision makes it clear that it is a
    residuary provision and allows an expenditure, not covered under Sections
    30 to 36, in computing the income chargeable under head "profits and gains
    of business or profession'', on fulfilment of the other requirements, namely,    E
    (i) the expenditure should not be in the nature of capital expenditure or
    personal expenses of the assessee; (ii) it should have been laid out or
    expended wholly and exclusively for the purposes of the business or profes-
    sion; (iii) it should have been expended in the previous year.
                                                                                     F
         The question is whether the amount in question can be treated as
    expenditure and whether it was expended wholly and exclusively for the
    purpose of the business of the appellant.

          In support of his contention that Rs.2,35,000 were spent for purchase
    of technical know-how, so it is a revenue expenditure, Mr. Reddy relied G
    upon a letter addressed by the Vice-President of the Eimco Corporation
    to the Director of K.C.P.Ltd. on April 14, 1965.

            The relevant excerpts of the said letter read as under :

            "In general, we agree that the organisation will follow that set forth   H
                                                                                        t

    1190                     SUPREME COURT REPORTS                   [2000] 1 S.C.R.

A               in the Memorandum and Articles of Association of the K.C.P.-
                Fives Lille - Cail Private Limited (a corporation of India), but with
                the following specific provisions to which we have agreed.

           1.    The Company will be organised and headquartered in India as
                 an Indian Corporation with broad corporate powers.
B
           2.    The name of the company will be EIMCO-K.C.P. Private Ltd.

           3.    There will be two subscribers for one share each - each partner
                 will designate one subscriber.

c          4.    Authorised capital is to be Rs. 1,00,00,000 consisting of 10,00,000
                 equity shares of Rs.10 each.

           5.    Each partner will subscribe to Rs. 4,70,000; of this amount each
                 will initially pay in Rs. 2,80,000 or equivalent after approval by
                 the Government of India and before commencement of opera-
D                tion; and the balance of the amount subscribed will be con-
                 tributed by each partner, in equal amounts, as and if required
                 for operation of the business.

           6.    The amount initially paid in by Eimco will primarily consist of
                 Eimco's know-how, valued at Rs. 2,35,000 and cash. Know-how
E
                 consists of the right and license to manufacture existing Eimco
                 Sedimentation and filtration equipment, along with the supply of
                 and/or the agreement to supply general technical data including
                 manufacturing drawings in the form as used and possessed by
                 Eimco, relating to the sales, application, selection, material re-
F                quirements, manufacture, installation and operation of such
                 equipment, including but not limited to test procedures, instruc-
                 tion manuals, technical manuals, general arrangement and detail
                 drawings, flow charts, research and development reports, sales
                 manuals and bulletins, operating reports on existing installations
                 and installation and operation manuals. The balance of the initial
G
                 investment will be in cash."

          A plain reading of the letter indicates that Eimco and K.C.P agreed
    to float the appellant company with authorised capital of Rs. 1,00,00,000
    consisting of 10,00,000 equity shares of Rs.10 each. Each of them agreed
H   to subscribe Rs. 4,70,000 out of which the amount equivalent to Rs. 2,80,000
    EIMCO K.C.P. LTD. v. C.I.T. (SYED. S. MOHAMMED QUADRI,J.] 1191

was to be paid (after approval by the Government of India and before the A
commencement of operation). Eimco valued the know- how etc. at a sum
of Rs. 2,35,000 and paid the balance in cash towards its contribution.

      What in effect was done by the appellant in allotting equity shares
of Rs. 2,80,000 to Eimco, was to reimburse the contribution of Eimco by
way of know-how, which can never be treated as expenditure much less an B
expenditure laid out wholly and exclusively for purposes of the business of
the appellant. It is not a case where after the incorporation, the appellant-
company in the course of the carrying on its business, spent the said
amount for acquiring any asset. Reliance by Mr. Reddy on the judgment
of this Court in Alembic Chemical Works Co. Ltd. v. Commissioner of C
Income-Tax, Gujarat, (1989) 177 ITR 377 is wholly inappropriate. There
know-how was acquired to produce higher yield and sub-culture of high
yielding strain of penicillin. The assessee-company was already engaged in
manufacture of antibiotics including penicillin before it acquired the know-
how. Therefore, it was a case of a running company acquiring know-how
to increase its yield and quality of its product and for the better conduct D
and improvement of the existing business and therefore the amount spent
on acquiring know-how was held to be revenue expenditure.

       In our view, the High Court has rightly concluded that allotment of
equity share by the appellant to Eimco, in the circumstance of the case,       E
cannot be termed as 'expenditure much less revenue expenditure' and
rightly answered the question referred to it against the appellant-assessee.
We find no merit in these appeals which are accordingly dismissed with
costs.

A.Q.                                                    Appeals dismissed.